From: Mark Buffington [mark_buffington@hotmail.com] Sent: Wednesday, June 26, 2002 10:56 PM To: rule-comments@sec.gov Subject: File No. S7-18-02 The purpose of this email is to express concern over the potential repeal of the trade-through disclosure rule. As a registered market maker on the Pacific Exchange, my concern over repeal of this rule may seem counter- intuitive, however, a close review of current practices in national options markets will reveal some alarming, potentially scandalous practices by large investment houses/brokerages. It is my opinion that repeal of the disclosure rule will only benefit large investment houses that are currently partaking in conflicted, unfair business practices. The background information in section A states that the goal of Congress is to make markets more competitive and efficient in the name of public interest. I find it difficult to understand how this will make markets more competitive and efficient. On the other hand, it is very clear to me how repeal of the disclosure rule will open up a system that is already flawed to more "gaming" by big brokerage/order flow provider firms. Essentially, repeal of such a rule will enable brokerages to justify trade throughs. As I am sure you are aware, most brokerage firms are increasingly internalizing a large portion of the customer orders they receive. What this means is that many investment houses both broker and "take the other side" of many of the option orders they receive from customers. They charge the customer a commission for brokering the order, and they try to make a profit by trading the option against that customer. Such an arrangement creates numerous potential conflicts of interest on the part of the investment house/brokerage. The first problem with this arrangement is that many of these orders are never exposed to true price competition. In many cases, crowd market makers never have the opportunity to improve a market if they desire. The entire trade is pre-negotiated by trading desks at brokerage firms that, in the end, are mostly influenced by profit motive. Large investment houses use their leverage as an "order flow provider" to trade an order at the most advantagous price, not for their customer, but for their firm. In addition, this leverage is used so that the firm can participate on the largest portion of the trade possible. In essence, crowd traders are now forced to evaluate one question every day: "How much am I willing to let a brokerage firm/order flow provider bend the rules in order to participate in tr! ading activities. This scenario could never be good for customers. As a market maker providing liquidity to options markets, I see the impact of internalization on market efficiency on a daily basis. In short, the result of large investment houses internalizing order flow is very damaging to public interest. Secondly, by seeing an order in advance, order flow providers are given an unfair advantage vis-a-vis other liquidity providers in that they can "front-run" an order by hedging the trade before a crowd has the chance to hedge the trade. This front-running takes place in a number of forms. Consistently, I see large firms sell options on behalf of the firm before large option sell orders by their customers ever reach the crowd. In this form, firms are front-running moves in the Implied Volatility of options. Many times, this action will negatively impact the price a customer eventually receives on an option order. In other cases, I see firms outright hedge their positions with stock before an order every reaches the crowd. The impact of front-running as a result of internalization is hard to measure or even detect, but I see its negative effect on public customers every day. As stated above, by repealing the trade through disclosure rule, the SEC is merely opening the door for more gaming by brokerages and order flow providers. De facto, the SEC will give these firms a means to justify their actions. The truth of the matter is that the SEC should take a hard look at the options markets and the practices of its largest participants. In no way does internalization benefit the public good. The issue here is one of objectivity. How can a broker honestly execute an order on behalf of their customer when that broker seeks to profit by taking the other side of a customer's trade? Nonetheless, every day and in increasing fashion, large investment houses are finding a way to fleece their customers by circumventing competitive trading environments. Repealing the trade through disclosure rule will only benefit investment houses and order flow providers at the expense of the option trading public. As long as investment houses continue to internalize order flow, one simple rule should apply: the more power the larger investment houses gain, the more public customers will be hurt. One need only look to the accounting industry to see the eventual outcome of a system that is fraught with conflict of interest. Sincerely, Mark A. Buffington Phoenix Capital, LLC -------------------------------------------------------------------------------- Get your FREE download of MSN Explorer at http://explorer.msn.com.